Midterm 3/20

An investment pays $1,500 half of the time and $500 half of the time. Its expected value and variance respectively are:

$1,000;250,000 dollars2

If an investment will return $1,500 half of the time and $700 half of the time, the expected value of the investment is:

$1,100.

Consider a one-year corporatebond that has a 20% probability of default. The payoff on the bond is $2,000 if the corporation does not default. The interest rate is 10%. If buyers of this bond are risk-neutral, this bond will sell for:

$1,454.54

If an investment has a 20%(0.20) probability of returning $1,000;a 30%(0.30) probability of returning $1,500; and a 50%(0.50) probability of returning $1,800; the expected value of the investment is:

$1,550.00

Which of the following best expresses the formula for determining the price of a U.S. Treasury bill that matures n periods from now per $100 of face value when the interest rate is i?

$100/(1 + i)n

The future value of $100 at a 5% per year interest rate at the end of one year is:

$105.00

The value of $100 left in a certificate of deposit for four years that earns 4.5% annually will be:

$119.25

Tom deposits funds in his savings account at the bank which is paying 3.5% interest. If he keeps his funds in the bank for one year he will have $155.25. What amount is Tom depositing?

$150.00

What is the present value of $200 promised two years from now at 5% annual interest?

$181.41

Suppose a family wants to save $60,000 for a child's tuition. The child will be attending college in 18 years. For simplicity, assume the family is saving for a one-time college tuition payment. If the interest rate is 6%, then about how much does this family need to deposit in the bank today?

$21,000

An investment will pay $2,000 half of the time and $1,400 half of the time. The standard deviation for this investment is:

$300

An investor deposits $400 into a bank account that earns an annual interest rate of 8%. Based on this information, how much interest will he earn during the second year alone?

$34.56

If the annual interest rate is 5%(.05), the price of a six-month Treasury bill would be:

$97.59

A 30-year Treasury bond as a face value of $1,000, price of $1,200 with a $50 coupon payment. Assume the price of this bond decreases to $1,100 over the next year. The one-year holding period return is equal to:

-4.17%.

If 10% is the annual rate, considering compounding, the monthly rate is:

1.0833%

One hundred basis points could be expressed as:

100%

According to the Expectations Theory of the term structure, if interest rates are expected to be 2%, 2%, 4%, and 5% over the next four years, which yield is the closest to the yield on a three-year bond today?

2.7%

Which of the following best expresses the payment a saver receives for investing their money for two years?

2PV(1 + i)

An investor puts $2,000 into an investment that will pay $2,500 one-fourth of the time;$2,000 one-half of the time, and $1,750 the rest of the time. What is the investor's expected return?

3.125%

A saver knows that if she put $95 in the bank today she will receive $100 from the bank one year from now, including the interest she will earn. What is the interest rate she is earning?

5.26%

In reading the national business news, you hear that mortgage rates increased by 50 basis points. If mortgage rates were initially at 6.5%, what are they after this increase?

7.0%

Assume the Expectation Hypothesis regarding the term structure of interest rates is correct. Then, if the current one-year interest rate is 4% and the two-year interest rate is 6%, then investors are expecting the future one-year rate to be:

8%

Suppose Tom receives a one-year loan from ABC Bank for $5,000.00. At the end of the year, Tom repays $5,400.00 to ABC Bank. Assuming the simple calculation of interest, the interest rate on Tom's loan was:

8.00%

The economy enters a period of robust economic growth that is expected to last for several years. How would this be reflected in the risk structure of interest rates?

A decrease in the interest rate spread

Interest-rate risk would not matter to which of the following bondholders?

A holder of a U.S. government bond that plans on holding it until it matures.

Systematic risk:

A risk that influences a large number of assets. Also, market risk.

Suppose that Ray Allen, a basketball player for the Miami Heat, will become a free agent at the end of this NBA season. Suppose that Allen is considering two possible contracts from different teams. Note that the salaries are paid at the end of EACH year. The interest rate is 10%. Based on this information, which of the following is true?

Allen should take the Portland contract because it has a higher present value.

Which of the following would lead to an increase in bond supply?

An improvement in general business conditions.

Which of the following would lead to a decrease in bond demand?

An increase in expected inflation.

The bond demand curve slopes downward because:

At lower prices the reward for holding the bond increases

Which of the following is not a reason why the yield to maturity can differ from the current yield?

Because the current yield moves in the opposite direction from price.

Bonds with the same tax status and ratings:

Can have different yields due to different maturities

Which of the following best expresses the equation for one-year holding period return?

Current yield + capital gain

The bond supply curve slopes upward because:

For companies seeking financing, the higher the price of bonds the more attractive it is to sell bonds

Which of the following is true of interest-rate risk?

Individuals owning long-term bonds are exposed to greater interest-rate risk.

Suppose the economy has an inverted yield curve. According to the Expectations Hypothesis, which of the following interpretations could be used to explain this?

Interest rates are expected to fall in the future.

Investment A pays $1,200 half of the time and $800 half of the time. Investment B pays $1,400 half of the time and $600 half of the time. Which of the following statements is correct?

Investment A and B have the same expected value, but A has lower risk than B.

Which of the following is true?

Investments that pay a return over a longer time horizon generally have less risk.

Suppose the economy has an inverted yield curve. According to the Liquidity Premium Theory, which of the following interpretations could be used to explain this?

Investors expect an economic slowdown.

The risk structure of interest rates says:

Lower rated bonds will have higher yields

If a one-year bond currently yields 4% and is expected to yield 6% next year, the Liquidity Premium Theory suggests the yield today on a two-year bond will be

More than 5%.

Hedging is possible only when investments have:

Opposite payoff patterns

Which of the following best expresses the proceeds a lender receives from a one-year simple loan when the annual interest rate equals i?

PV(1 + i)

The U.S. Treasury yield curve:

Shows the relationship among bonds with the same risk characteristics but different maturities

The two best known bond rating services are:

Standard & Poor's and Moody's Investment Services.

Consider the price paid for debt issued by the State of California. Which of the following would lead to a decrease in the value of State of California bonds?

The State of California experiences a fiscal crisis that makes it less likely it will be able to honor its interest payments.

Tom obtains a car loan from Old Town Bank.

The car loan is Tom's liability and an asset for Old Town Bank

The risk spread is:

The difference between the bonds yield and the yield on a U.S. treasury bond of the same maturity

The higher the future value of the payment the:

The higher the present value

The shorter the time until a payment the:

The higher the present value

Diversification can eliminate:

The idiosyncratic risk in a portfolio

The bond rating of a security reflects the:

The likelihood the lender/borrower will be repaid by the borrower/issuer

In calculating the current yield for a bond the:

The present value of the capital gain/loss is ignored

Doubling the future value will cause:

The present value to double

The fact that over the long run the return on common stocks has been higher than that on long-term U.S. Treasury bonds is partially explained by the fact that:

The risk premium is higher on common stocks.

The Expectations Hypothesis suggests the:

The slope of the yield curve depends on the expectations for future short-term rates

A student receives a five-year loan to pay for a $2,000 used car. The lender and the student agree to an 8% interest rate on a fixed-rate loan. Expected inflation was estimated to equal 2.5%, but unexpectedly decreases to 2%. Which of the following is true?

The student is made worse off because her real cost of borrowing is higher.

Which of the following statements pertaining to the yield curve is not true?

The yield curve shows the difference in default risk between securities.

A flight to quality should result in the:

The yield on U.S. Treasury securities falling and the price of corporate bonds falling

Commercial paper refers to:

Unsecured short-term debt issued by corporations and governments

Which of the following statements is most correct?

Usually higher risk premiums are associated with lower expected returns.

Which fact about the term structure is the Expectations Theory unable to explain?

Why longer-term yields tend to be higher than shorter-term yields.

All other factors held constant, an investment:

With more risk should sell for a lower price and offer a higher expected return

Which of the following statements is most accurate?

Yield to maturity will exceed the coupon rate if the bond is purchased for face value.

In 2003, ratings agencies downgraded bonds issued by the State of California several times. How will this affect the market for these bonds?

Yields on these bonds will increase.

Financial instruments used primarily to transfer risk would include all of the following, except:

a future contract

When the yield curve slope is more upward sloping than usual, people are expecting:

a future rise in short-term interest rates.

An investment with a large spread between possible payoffs will generally have:

a high standard deviation.

Interest-rate risk results from:

a mismatch between an individual's investment horizon and a bond's maturity.

A share of Ford Motor Company stock is an example of:

a standardized financial system

A financial instrument would include:

a written obligation, a transfer of value, a future date, and certain conditions

A risk-averse investor will:

always prefer an investment with a certain return to one with the same expected return but that has any amount of uncertainty

The risk premium that investors associate with a bond increases with all of the following except:

an improved bond rating.

Suppose that the expected return on bonds falls relative to other assets. In the bond market this will result in:

an increase in the price of bonds.

Secondary financial markets:

are financial markets where existing securities are bought and sold.

The interest-rate risk that is associated with bond investing:

arises because of a mismatch between the investor's investment horizon and the maturity of the bond.

A flight to quality refers to a move by investors:

away from low-quality bonds towards high-quality bonds.

Under the expectations hypothesis, if expectations are for lower inflation in the future than what it currently is, the yield curve's slope will:

be negative

As general business conditions improve, we would witness the following in the bond market:

bond prices decreasing.

If the federal government were to offer larger tax breaks on the purchase of new equipment for businesses, all other factors constant, we would expect to see the:

bond supply curve shift right.

If the U.S. government's borrowing needs increase, in the bond market this would be seen as the:

bond supply curve shifting right.

Money markets are where trades occur for:

bonds of all maturities

A permanent increase of borrowing by the U.S. Treasury to finance growing budget deficits will:

cause the yield on U.S. Treasury bonds to increase, but still be lower than corporate bonds.

Given a choice between two investments with the same expected payoff most people will:

choose the one with the lower standard deviation.

When expected inflation increases, for any given nominal interest rate the:

cost of borrowing decreases and the desire to borrow increases.

A 10-year Treasury note as a face value of $1,000, price of $1,200, and a 7.5% coupon rate. Based on this information, we know the:

coupon payment on this bond is equal to $75.

If a bond's purchase price equals the face value the:

coupon rate equals the yield to maturity, which equals the current yield.

A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20 years to maturity has a:

current yield and coupon rate equal to 6.22% and a coupon rate above this.

Suppose there isa decrease in the price at which a bondholder sells her bond. In this case, the holding period return will:

decrease, since this lowers the capital gain.

As inflation increases, for any fixed nominal interest rate, the real interest rate:

decreases

The variance of a portfolio containing n assets with independent returns:

decreases as n increases.

Today the primary distinction between direct and indirect finance is in:

direct finance the asset holder has a direct claim on the borrower while in indirect finance the asset holder has a claim on a financial institution.

Roles served by financial markets include the following, except:

eliminating risk

Financial markets:

enable buyers and sellers to exchange risk by buying and selling financial instruments.

A promise of a $100 payment to be received one year from today is:

equally valuable as a payment received today if the interest rate is zero.

If the quantity of bonds supplied exceeds the quantity of bonds demanded, bond prices would:

fall and yields would rise.

The greater the standard deviation of an investment the:

greater the risk

All of the following are true about the risk spread except it should:

have a direct relationship with the bond's price.

Under the Liquidity Premium Theory, if investors expect short-term interest rates to remain constant, the yield curve should:

have a positive slope.

Diversification is the principle of:

holding more than one asset to reduce risk.

High oil prices tend to harm the auto industry and benefit oil companies;therefore, high oil prices are an example of:

idiosyncratic risk.

Unexpected inflation can benefit some people/firms and harm others. This is an example of:

idiosyncratic risk.

If the risk on foreign government bonds increases relative to U.S. government bonds, the price of U.S. government bonds should:

increase as the demand for these bonds increases.

Suppose that the return on assets other than bonds falls. In the bond market this will result in a(n):

increase in the price of bonds.

During a recession you would expect the difference between the commercial paper rate and the yield on U.S. T-bills of the same maturity to:

increase reflecting the possibility of higher default risk for commercial paper.

Consider a zero-coupon bond with a $1,100 payment in one year. Suppose the interest rate decreases from 10% to 8%. The price of this bond:

increases from $1,000 to $1,018.

When considering different investments, a risk-averse investor is most likely to focus on purchasing:

investments that offer the lowest standard deviation in the investments' expected rates of return for any given expected rate of return.

A financial intermediary:

is a third party that facilitates a transaction between a borrower and a lender

When the price of a bond is above face value the yield to maturity:

is below the coupon rate.

A primary financial market is:

is one in which newly issued securities are sold

The expected value of an investment:

is the probability-weighted sum of the possible outcomes

Sometimes spreading has an advantage over hedging to lower risk because:

it can be difficult to find assets that move predictably in opposite directions.

The value of a financial instrument rises as:

it is less likely the payment will be made.it is less likely the payment will be made.

The reason for the increase in inflation risk over time is due to the fact that:

it is more difficult to forecast inflation over longer periods of time.

If a saver has a positive rate of time preference then the present value of $100 to be received 1 year from today is:

less than 100.

If financial markets didn't exist:

liquidity would diminish, reducing the flow of funds between borrowers and savers.

The demand for U.S. government bonds is high relative to other bond issues because:

market for U.S. government bonds is more liquid than most if not all other bond markets.

In considering the holding period return, the longer the term of the bond the:

more important is the capital gain.

Bond prices and yields:

move together inversely

The risk spread on bonds fluctuates mainly because:

new information about a borrower's financial condition becomes available.

When measuring the risk of an asset:

one must measure the uncertainty about the size of future payoffs.

The price of a coupon bond can best be described as the:

present value of the face value plus the present value of the coupon payments.

An increased risk of a financial crisis in the euro area should cause the:

price of U.S. Treasury bonds to increase and the yield on other bonds to increase.

When a loan is amortized, it means the:

principal and interest are paid off by the borrower over the life of the loan.

Compounding refers to the

process of earning interest on both the principal and the interest of an investment.

A zero-coupon bond refers to a bond which:

promises a single future payment

Which formula below best expresses the real interest rate, (r)?

r = i -πe

At any fixed interest rate, an increase in time, n, until a payment is made:

reduces the present value.

The risk structure of interest rates refers to the:

relationship among the interest rates of bonds from different issuers with the same maturities.

A risk-averse investor compared to a risk-neutral investor would:

require a higher risk premium for the same investment as a risk-neutral investor.

An individual who is risk-averse:

requires larger compensation when the risk increases.

Under the Liquidity Premium Theory a flat yield curve implies:

short-term interest rates are expected to decrease.

When the yield curve is downward sloping:

short-term yields are higher than long-term yields

Any theory of the term structure of interest rates needs to explain each of the following, except why:

short-term yields are usually higher than long-term yields.

An automobile insurance company that writes millions of policies is practicing a form of:

spreading risk.

If the U.S. government's borrowing needs increase, all other factors constant the:

supply of bonds will increase.

Changes in general economic conditions usually produce:

systematic risk.

The "coupon rate" is:

the annual amount of interest payments made on a bond as a percentage of the amount borrowed

A decrease in the nation's wealth, all other factors constant, would cause:

the bond demand curve to shift left.

Default risk is the risk associated with:

the bond issuer not being able to make the promised payments.

The price of a coupon bond is determined by taking the present value of:

the coupon payments and adding this to the face value.

The lower the interest rate, the:

the lower in the present value

Suppose that general business conditions improve, and at the same time, wealth increases. Based on this information, we know that:

the quantity of bonds increases.

The yield on a 30-year U.S. Treasury security is 6.5%; the yield on a 2-year U.S. Treasury bond is 4.0%. This data indicate:

the yield curve is upward sloping.

Inverted yield curve is a valuable forecasting tool because:

the yield curve seldom is inverted and can signal an economic slowdown.

A company that continues to have strong profit performance during an economic downturn when many other companies are suffering losses or failing should see:

their bond rating maintained or actually increase.

Bonds issued by the U.S. Treasury are referred to as benchmark bonds because:

they are highly liquid and virtually free of default risk.

U.S. Treasury securities are considered to carry no risk spread because:

they are the closest thing to default-risk free that an investor can obtain.

If a bond's rating improves it should cause the bond's price:

to increase and its yield to decrease, all other factors constant.

Suppose that interest rates are expected to remain unchanged over the next few years. However, there is a risk premium for longer-term bonds. According to the liquidity premium theory, the yield curve should be:

upward sloping and relatively flat.

We would expect the relationship between the risk spread on Baa bonds and U.S. Treasury securities of similar maturities to:

vary inversely with economic growth.

We should expect a country that experiences volatile inflation to also have:

volatile real interest rates but stable nominal rates.

The fundamental characteristics influencing the value of a financial instrument include each of the following except:

where the instrument is traded

We would expect the risk spread between Baa bonds and U.S. Treasury securities of the same maturities to:

widen during periods of economic recession.

If the purchase price of a bond exceeds the face value, the yield to maturity:

will be less than the coupon rate because the capital gain will be negative.

The impact of a decrease in expected inflation in the bond market will have a relatively large effect on the prices of bonds prices because the bond demand curve:

will shift right but the bond supply curve shifts left.

The slope of the yield curve seems to predict the performance of the economy usually:

with a one-year lag.

The Expectations Hypothesis cannot explain why:

yield curves usually slope upward.

As general business conditions improve, all other factors constant the:

yield on bonds will increase.

Compound interest means that:

you get interest on interest